CHAPTER 20
Options Markets:
Introduction
Investments, 8th edition
Bodie, Kane and Marcus
Slides by Susan Hine
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Option Terminology
•
•
•
•
•
Buy - Long
Sell - Short
Call
Put
Key Elements
– Exercise or Strike Price
– Premium or Price
– Maturity or Expiration
20-2
Market and Exercise Price Relationships
In the Money - exercise of the option would be
profitable
Call: market price>exercise price
Put: exercise price>market price
Out of the Money - exercise of the option would
not be profitable
Call: market price<exercise price
Put: exercise price<market price
At the Money - exercise price and asset price are
equal
20-3
Figure 20.1 Stock Options on IBM
20-4
American vs. European Options
American - the option can be exercised at
any time before expiration or maturity
European - the option can only be exercised
on the expiration or maturity date
20-5
Different Types of Options
•
•
•
•
•
Stock Options
Index Options
Futures Options
Foreign Currency Options
Interest Rate Options
20-6
Payoffs and Profits at Expiration - Calls
Notation
Stock Price = ST Exercise Price = X
Payoff to Call Holder
(ST - X) if ST >X
0
if ST < X
Profit to Call Holder
Payoff - Purchase Price
20-7
Payoffs and Profits at Expiration - Calls
Payoff to Call Writer
- (ST - X)
if ST >X
0
if ST < X
Profit to Call Writer
Payoff + Premium
20-8
Figure 20.2 Payoff and Profit to Call
Option at Expiration
20-9
Figure 20.3 Payoff and Profit to Call
Writers at Expiration
20-10
Payoffs and Profits at Expiration - Puts
Payoffs to Put Holder
0
if ST > X
(X - ST)
if ST < X
Profit to Put Holder
Payoff - Premium
20-11
Payoffs and Profits at Expiration – Puts
Continued
Payoffs to Put Writer
0
if ST > X
-(X - ST)
if ST < X
Profits to Put Writer
Payoff + Premium
20-12
Figure 20.4 Payoff and Profit to Put
Option at Expiration
20-13
Equity, Options & Leveraged Equity
Investment
Strategy
Investment
Equity only
Buy stock @ 100 100 shares
$10,000
Options only
Buy calls @ 10
Leveraged
equity
Buy calls @ 10
100 options
Buy T-bills @ 3%
Yield
1000 options $10,000
$1,000
$9,000
20-14
Equity, Options Leveraged Equity Payoffs
IBM Stock Price
$95
$105
$115
All Stock
$9,500
$10,500
$11,500
All Options
$0
$5,000
$15,000
Lev Equity
$9,270
$9,770
$10,770
20-15
Rates of Return
IBM Stock Price
$95
$105
$115
All Stock
-5.0%
5.0%
15%
All Options
-100%
-50%
50%
Lev Equity
-7.3%
-2.3%
7.7%
20-16
Figure 20.5 Rate of Return to Three
Strategies
20-17
Table 20.1 Value of Protective Put
Portfolio at Option Expiration
20-18
Figure 20.6 Value of a Protective Put
Position at Option Expiration
20-19
Figure 20.7 Protective Put versus Stock
Investment (at-the-money option)
20-20
Table 20.2 Value of a Covered Call
Position at Expiration
20-21
Figure 20.8 Value of a Covered Call
Position at Expiration
20-22
Option Strategies
Straddle (Same Exercise Price)
Long Call and Long Put
Spreads - A combination of two or more call
options or put options on the same asset with
differing exercise prices or times to expiration.
Vertical or money spread:
Same maturity
Different exercise price
Horizontal or time spread:
Different maturity dates
20-23
Table 20.3 Value of a Straddle Position
at Option Expiration
20-24
Figure 20.9 Value of a Straddle at
Expiration
20-25
Table 20.4 Value of a Bullish Spread
Position at Expiration
20-26
Figure 20.10 Value of a Bullish Spread
Position at Expiration
20-27
Put Call Parity
If the prices are not equal arbitrage will
be possible
X
C
 S0  P
T
(1  rf )
20-28
Put Call Parity - Disequilibrium Example
Stock Price = 110 Call Price = 17
Put Price = 5
Risk Free = 5%
Maturity = 1 yr
X = 105
X
C
 S0  P
T
(1  rf )
117 > 115
Since the leveraged equity is less expensive,
acquire the low cost alternative and sell the high
cost alternative
20-29
Table 20.5 Arbitrage Strategy
20-30
Optionlike Securities
•
•
•
•
Callable Bonds
Convertible Securities
Warrants
Collateralized Loans
20-31
Figure 20.11 Values of Callable Bonds
Compared with Straight Bonds
20-32
Figure 20.12 Value of a Convertible
Bond as a Function of Stock Price
20-33
Figure 20.13 Collateralized Loan
20-34
Figure 20.14 Return on Indexed
Linked CD
20-35
Table 20.6 Prices of Digital Options on
Initial Jobless Claims
20-36
Figure 20.15 Implied Probability of Jobless
Claims Derived from Traded Digital Options
20-37
Exotic Options
•
•
•
•
•
Asian Options
Barrier Options
Lookback Options
Currency Translated Options
Digital Options
20-38